The Family Firm Ownership Puzzle

Conventional wisdom suggests that family shareholders should exit their large, concentrated equity stakes in publicly traded firms and seek benefits arising from diversification. However, founding families maintain a substantive and undiversified stake in many publicly traded U.S. firms. The classical models without ambiguity cannot quantitatively explain the decision of these family owners to hold a large portion of their wealth in the family firm. We propose a robust portfolio-choice model with ambiguity about the return volatility, where family owners can exploit their information advantage about their firm to reduce the ambiguity of their firm relative to other firms in a diversified portfolio. Our model rationalizes family owners’ decision to concentrate their wealth in the family firm and predicts that the less wealthy, less risk averse, and younger families are more likely to exit the firm. The empirical results based on more than 500 U.S. family firms’ cross-section data support these novel predictions. Based on family ownership and exit decisions, we find that information advantage and ambiguity about return volatility are critical to understanding the family owners’ decision to maintain substantive control in countries with well-developed financial markets and legal regimes.